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Are The Trendpilot ETNs Better Than Broad Market ETFs?

Although the markets have started the year on a solid note, significant amounts of volatility remain in equities. Huge issues hang over the market—be it in the form of job creation, Iranian worries, or European woes—and any one of these problems could derail growth later this year.

Thanks to this and the impressive pace of the market’s gains so far this year, some investors may be considering dialing back exposure to the broad markets, or at least taking a closer look at more defensive choices instead. This strategy could be ideal for those seeking to lock in some gains or those who are forecasting a long slump or a return to more stable markets in the second quarter (see more on ETFs in the Zacks ETF Center).

One way to accomplish this task while still maintaining exposure to the broad markets is via the relatively new Trendpilot ETNs. These innovative notes from RBS utilize a systematic trend-following strategy which can help to cut down on losses, assuming that trends hold.

Trendpilot ETN Methodology Explained

In essence, the strategy consists of two components; a broad benchmark and a Treasury bond component. When the broad benchmark—or main asset—is at or above its 200 day simple moving average for five consecutive days, a positive trend is established. When this takes place, the note will be fully allocated to the broad benchmark or asset in question.

However, when the index is in a bearish trend—the benchmark is trending below its 200 day simple moving average for five consecutive days—the product will establish a more defensive position. This means the product will cycle out of its stock index or asset and focus in on T-Bills until a positive trend is once again established (read Three Outperforming Active ETFs).

With this focus, the Trendpilot ETNs look to avoid the downtimes in a particular market segment and only invest in a sector when it is trending higher. This can help to avoid losses but sometimes the five day level may be too quick of a time period for some trends to develop.

ETN Ramifications

Investors should also note that the products are structured as ETNs as opposed to exchange traded funds. This is an important distinction for trend following products that cycle quickly in and out of different asset classes (also read ETFs vs. ETNs: What’s The Difference?).

Basically, ETNs don’t actually hold any securities; instead they are unsecured senior debt obligations from the issuing institution. This means that when the trend cycles from one product to another it just shifts which index it is tracking, nothing is actually bought or sold. Thanks to this, tracking error for these products looks to be non-existent, something that cannot be said for implementing a similar strategy on your own.

The main downsides to the technique are cost and volume. Currently, of the five Trendpilots, not a single one has more than $70 million in AUM while three have less than $10 million in assets.

Additionally fees are quite high compared to similar non-trend following products; depending on the asset being tracked fees can reach 100 basis points and only go down to 50 basis points a year when products are tracking T-Bills instead.

While the strategy certainly sounds interesting, it clearly has it downsides as well. As a result, the real test for the Trendpilot products should be when investors put them up against more traditional rivals. Below, we take a look at the five Trendpilot ETNs and see how they have done against their more popular counterparts over the past 52 week period:

RBS Gold Trendpilot ETN

This ETN applies the Trendpilot methodology to gold, as measured by the spot price of the afternoon gold fixing price for good delivery in London. The ETN currently has $25 million in AUM and sees trading volume of about 12,000 shares each day (see ETF Investors: Beware The Coming ETN Backlash).

For comparison purposes, (GLD - Free Report) is easily the most popular fund tracking the pure gold space, although it is always focused on the precious metal. This has proven to be a winning strategy over the past 12 months as GLD has outperformed TBAR by a little over 375 basis points. If you add in the fee differential, it becomes even greater putting GLD’s outperformance over the 400 bps mark.

RBS NASDAQ-100 Trendpilot ETN

For a more tech focused play using the Trendpilot methodology, investors should take a closer look at TNDQ. The ETN cycles between the Nasdaq-100 and T-Bills, either giving exposure to short-term government debt or a tech focused index which includes the likes of Apple (AAPL), Microsoft (MSFT), and Google (GOOG).

An easy comparison between this ETN and a more traditional product is that of (QQQ - Free Report) . This ultra-popular ETF has added about 21.3% in the past 52 weeks compared to a 19.4% return for TNDQ in the same time period.

While QQQ has been the better choice over the long term, TNDQ has actually outperformed over the past three month period. The fund avoided a great deal of turmoil in early March and had a great start to the year, allowing the note to outperform QQQ by about 480 basis points in the first quarter.

RBS Oil Trendpilot ETN

In order to play the crude oil market, investors can also consider RBS’ TWTI. The note targets WTI Crude oil, focusing on the 12 contracts that are closest to expiration along the curve. Investors should also note that this product has a slightly higher expense ratio at 1.1% and that it looks at a trailing 100 level to determine its baseline.

One of the more popular oil ETFs that could be a competitor is the United States Oil Fund (USO - Free Report) . The product also targets WTI crude, and over the past 52 weeks has gained just over 13.5%. This easily beats out TWTI’s 9.7% gain in the same time frame, especially when factoring in expenses (see Is An Oil Sands ETF On The Horizon?).

However, in the recent one month period TWTI has easily outperformed USO and a similar trend took place over the past quarter. Still, investors should note that over the past six months, thanks to TWTI slowly cycling into crude oil, the product missed out on a lot of gains and underperformed significantly from this time frame (also, the product has outperformed (USL - Free Report) over the past three month period. Arguably, this fund is a better comparison but hasn’t been around long enough to do a full year study).

RBS US Large Cap Trendpilot ETN

Easily the most popular Trendpilot product is TRND which focuses in on large cap U.S. stocks that make up the S&P 500 index. The product has accumulated nearly $70 million in AUM and trades a respectable 20,000 shares a day.

For comparison purposes, investors can look to (SPY - Free Report) , the most popular ETF in the world. This fund also focuses in on the S&P 500 but does not have the T-Bill component like TRND. Although SPY has been much more volatile—and was a bigger loser in the worst of 2011—the fund has come roaring back and is now easily beating TRND over the past year, outgaining the fund 5% to -1.9%.

RBS US Mid Cap Trendpilot ETN

The second most popular Trendpilot ETN is TRNM, a product with a mid cap focus. This note looks to cycle between 3-month U.S. Treasury bills and the S&P Mid Cap 400 Total Index, a benchmark that comprises roughly 7% of the American equity market (see Mid Cap ETF Investing 101).

A major non-trend following competitor of TRNM is iShares’ (IJH - Free Report) . The product follows the S&P Mid Cap 400 and currently has over $10 billion in AUM. Much like other products on this list, IJH has thoroughly crushed its Trendpilot counterpart, losing 1.6% over the past year compared to a 12.6% loss for TRNM. The note did have less of a total drawdown though, so it could be a better choice for restless investors, although it was a little late to the party when the market moved higher.

Thanks to these trends, investors should think twice about the Trendpilot methodology. While the products are undoubtedly interesting, the fees are quite high and they can lag in bull markets. Yet, with that being said, bear markets and those with clear trends seem to serve this strategy well, so if you believe the market will face either of these situations, the segment could be worth a closer look.

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